Daily Newsletter, Sunday, 5/11/2014

Table of Contents

Leaps Trader Commentary

A Tale Of Two Markets

by James Brown

Investors appear to be facing two different markets. We have the big cap blue chip names, which are hitting new highs and the small cap and momentum names, which are hitting new relative lows. It was a slow week for domestic economic and foreign economic data was generally weak with China still showing signs of a slowdown. Meanwhile Russian President Putin urged Ukrainian rebels to postpone a controversial vote this weekend. It was a request they ignored and the fallout could impact markets. The week ending May 9th saw the Dow Jones Industrial Average tag new all-time highs and close up +0.4%. The S&P 500 index lost -0.14% for the week. The NASDAQ composite lost -1.26%. The small cap Russell 2000 index fell -1.9% with the $RUT closing below technical support at its simple 200-dma for the first time since 2012.

Economic Data

There were only a couple of notable economic reports last week. The wholesale inventory data rose +1.1% in March. This follows an upwardly revised February gain of +0.7%. The ISM non-manufacturing index improved from 53.1 in March to 55.2 in April. Numbers above 50.0 suggest growth and April was the best reading since August 2013.

Overseas Data

The Bank of England (BoE) and the European Central Bank (ECB) both held an interest rate meeting last week. The BoE left rates unchanged at 0.5% and left their QE program unchanged at 375 billion pounds. The ECB also left rates unchanged but ECB President Mario Draghi said the central bank is ready to act (that means they're ready with their own QE program) at the next meeting in June if the data warrants new action.

The European Commission lowered their 2015 GDP estimates for the Eurozone from 1.8% down to 1.7% growth. Meanwhile Eurozone Retail Sales increase +0.3% for the month, which was better than the -0.2% estimate. Eurozone PPI (wholesale inflation gauge) dropped -0.2% month over month. The year over year reading is down -1.6%. Germany said their industrial production dropped -0.5% for the month, which was worse than expected. German factory orders also came in worse than expected with a -2.8% decline.

The big headline for the week was China's HSBC manufacturing PMI number, which fell from 48.3 to 48.1, marking yet another month below the 50.0 level suggesting a continued decline in their economy. The China HSBC services PMI dipped from 51.9 to 51.4. China did say their trade surplus improved last month jumping from $7.71 billion to $18.45 billion, which was better than the $14 billion estimate. Exports improved significantly from a -6.6% drop to +0.9% gain. The country continues to work on massive infrastructure projects and imported a record-setting 83.4 million tons of iron ore in April.

China continues to bully their neighbors. You may recall how China started provoking Japan with a new aggressive stance over some uninhabited islands in the East China Sea last year. We're talking about eight small islands with a total area of about seven square kilometers. Japan's claim dates back to 1895. China started claiming the islands were theirs and recently enlarged their official air space defense zone to include the islands. You can read more about the disagreement
here.

Now China is trying to bully its southern neighbor Vietnam. Last week China moved their brand new deep water oil rig into Vietnam waters and started drilling. Vietnam is loudly protesting this invasion into their exclusive economic zone. Of course China says it's not Vietnam's. The two countries have been ramming each other's ships as the tensions rise. You can read more about it
here and
here.

Ukraine-Russian Conflict

The situation in Eastern Ukraine seemed to cool a bit last week. Russian President Vladimir Putin "tried" to help de-escalate the crisis by urging Ukraine seditionists to postpone a vote on an independence referendum scheduled for May 11th in the Ukraine cities of Donetsk and Lugansk. The rebels declined Putin's request and the vote is in progress.

Plenty of local Ukrainians consider these referendums to be fraud but that hasn't stopped a significant turnout by citizens in these two cities. The rebels hope to have all the ballots counted by Monday afternoon so there could be an official announcement of east Ukraine independence by Monday night or Tuesday. This will only heighten tensions in the area and could rattle equity markets.

The Kiev government and western nations like the United States will not recognize these votes just like they did not recognize the vote in Crimea. That didn't stop the Crimean vote from happening or stop Russia from annexing the region. One likely scenario is that these new "independent" Eastern Ukraine republics, assuming a successful vote in favor of self rule, will label the Ukraine army as terrorists and will then request Russia to intervene and send in Russian troops as peace keepers. Fast forward a few weeks and they will be another vote to join the Russian Federation and Russia gains the eastern half of Ukraine.

Major Indices:

The S&P 500 index has spent the last two weeks churning sideways. Last week saw a bounce off 1860 and a failure at resistance near 1890. The long-term trend (see weekly chart) is still higher but technical indicators are mixed.

The 1890-1900 zone remains significant resistance but a breakout past 1900 would be very bullish and likely spark significant short covering. Any such "breakout" needs to be more than just a few points above the 1900 level.

If this index rolls over again then we can watch for short-term support at 1860, 1840 and probably the 1800 level.

Year to date the S&P 500 is up +1.6%.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The NASDAQ composite lost -1.26% for the week. It did bounce twice near the 4,025 level but the index is still struggling with a bearish trend of lower highs. The 50-dma is rolling over. The trend is likely down until the NASDAQ closes above 4200 again.

If we see the NASDAQ close below its simple 200-dma it will probably signal a deeper correction. A normal -10% correction from the recent highs near 4370 would be 3933 (most likely the 3900 level). If you subscribe to the view that the NASDAQ is building a bearish head-and-shoulders pattern then a close below the 3950 level could signal another -400 point drop toward 3500-3600.

Year to date the NASDAQ composite is down -2.6%.

chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ index:

The small cap Russell 2000 index ($RUT) bounced on Friday (+0.89%) and pared its weekly loss to -1.9%. The index is down about -9.5% from its highs and it closed below technical support at its simple 200-dma for the first time since 2012.

Is the correction over with the $RUT down -10% or does it still have farther to fall? Last year's rally is broken and the intermediate trend is lower. Until we see the $RUT break through its trend line of lower highs we have to assume the path of least resistance is down.

The $RUT is down -4.6% year to date.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index

There are pockets of strength in the blue-chip names. The Dow Jones Industrial Average (a 30-component index) tagged new all-time highs this past week. The Industrials look poised to breakout to new highs on its weekly chart. The Dow Jones Transportation Average ($TRAN) is also flirting with all-time highs, which is bullish for the broader market if you believe in Dow Theory.

Weekly chart of the Dow Jones Industrial Average

Weekly chart of the Dow Jones Transportation Average

Economic Data & Event Calendar

The pace of economic data picks up again this week.
We'll get retail sales data in the U.S. There will be two Federal Reserve regional surveys. We'll see GDP estimates from Japan and the Eurozone.

We will also see the tail end of Q1 earnings season. The earnings cycle is considered over when Wal-mart (WMT) reports earnings on Thursday.
Thus far 451 of the S&P 500 components have reported. 68% of them have beaten Wall Street's lowered estimates. 22% have missed estimates.

Economic and Event Calendar

- Monday, May 12 -
reaction to independence referendums in Ukraine

- Tuesday, May 13 -
U.S. Retail Sales data for April
Import/export prices
Business Inventories for March

Technically U.S. stocks are still in a bull market. It just doesn't feel like one as market leadership narrows. The NASDAQ and Russell 2000 are sinking while money flows into the perceived safety of big cap blue chip names. Money managers want to be in liquid securities so they can get out of quickly if the market really starts to sink.

Speaking of flows the latest fund flow data suggest the sell-in-May theme is real. Data from ICI showed that investors pulled out $3.9 billion from the stock market for the week ending April 30th. That's the biggest outflows of the year. We haven't seen outflows that large since the $4.9 billion investors pulled out back in May 1st, 2013.

The folks at Avondale Asset Management posted some great observations this week. Defensive names have been outperforming, which is not normally a positive signal for further market gains. Mom and pop investors are the most invested in the stock market since September 2007. That happened to be the top of the market just before stocks rolled over into the 2008-2009 bear market. The current U.S. economic expansion, however slow it might seem, is now the 6th longest on in the country's history. The bull market is the 4th longest in history. At the same time investors seem to be more willing to overlook or ignore disappointing economic data. This is not a recipe for strong market gains.

Investors still need to keep one eye on U.S. bond yields. The bond market looks poised to rally and the yield on the 10-year note looks like it's coiling for a breakdown from its recent trading range. A drop past last week's low of 2.57% or the 2.5% level, depending on your risk tolerance, could be seen as a sell signal for stocks. It means "smart money" is pouring money into bonds, likely because they're worried about the stock market.

chart of the 10-year U.S. bond yield

I am suggesting caution. Summers are seasonally the weakest time of year for stocks and summers ahead of a midterm election tend to be more volatile. This year we have the added bonus of a civil war brewing in Ukraine.

There are pockets of strength with big cap names still drifting higher but if the broader market continues to sink it will eventually drag everything lower. You've probably heard the term, "a rising tide lifts all boats." The opposite is true as well. All boats are going to sink in a receding tide of investor sentiment.

New Plays

Divergence Continues

by James Brown

The markets are little changed from a week ago. The big cap indices are still drifting higher while broader market indices like the NASDAQ and Russell 2000 continue to sink. This divergence is not bullish for the market as a whole.

Meanwhile the situation in Ukraine could flare up again following a vote on an independence referendum in Eastern Ukraine this Sunday (May 11th). The aftermath of this vote could spook investors this coming week. The Ukraine government is not going to accept these votes as legal or binding and violence will likely increase. This could bring Russia across the border.

I am not adding any new trades tonight. We do have multiple watch list candidates that could be triggered this week if they continue to outperform.

Play Updates

Churning Sideways

by James Brown

Closed Plays

CLX hit our stop loss.

Play Updates

Big Lots Inc. - BIG - close: 39.02

Comments: 05/11/14:
After a four-week rally BIG posted some profit taking with a minor loss of less than a dollar. Shares are currently hovering above short-term support near $38.50 and its 30-dma. If the stock market rolls over we could see BIG testing its 50-dma or the $36.00 level. Investors may want to wait for this stock to close above the $40.00 mark before initiating new positions.

04/22 trade opens. BIG opened at $39.29
*option entry price is an estimate since the option did not trade at the time our play was opened.
04/21 BIG closed above our trigger at $39.25

Current Target: BIG @ 47.00
Current Stop loss: 35.75
Play Entered on: 04/22/14
Originally listed on the Watch List: 04/13/14

Caterpillar Inc. - CAT - close: 105.06

Comments: 05/11/14:
CAT made headlines this past week with plans to raise $2 billion in capital with long-dated bonds. The company plans to sell $1 billion in 10-year notes, $500 million in 30-year notes and $500 million in 50-year bonds. The news didn't have much impact on the stock price.

Shares of CAT are essentially unchanged for a week with a five-cent gain. If you think the market is going to correct lower then you may want to wait for CAT to pullback toward what should be support near $100 or its 50-dma. If you are not expecting a market pullback then consider waiting for CAT to close above $106.00 before initiating new positions.

Earlier Comments:
Our long-term target is the $115-125 zone. Currently CAT's point & figure chart is bullish with a $126 target.

04/27/14 new stop @ 98.45
04/03/14 trade opens. CAT @ 101.92
*option entry price is an estimate since the option did not trade at the time our play was opened.
04/02/14 CAT meets our entry trigger with a close above $101.00

Comments: 05/11/14:
DIS delivered a very strong earnings report last week and ended the week with gains. Analysts were expecting a profit of 96 cents a share on revenues of $11.24 billion. DIS delivered $1.11 a share with revenues climbing +10% to $11.65 billion. Big screen success with movies like Thor (2) and Frozen helped fuel a $1.8 billion in movie revenues.

The stock looks poised to challenge resistance in the $83-84 zone soon. I am raising our long-term exit target from $89 to $97.50. I am also raising our stop loss to $75.75.

05/11/14 new stop @ 75.75, adjust exit target from $89 to $97.50
04/27/14 DIS looks poised to hit new relative lows and our stop loss
04/13/14 investors may want to take profits now. DIS could be headed for $70.00
03/09/14 new stop loss @ 74.75, traders may want to take some money off the table here. DIS is overbought and due for a dip.
03/02/14 new stop loss @ 71.75
02/16/14 more conservative traders may want to take profits now.
We are adjusting our long-term target from $84 to $89
01/05/14 new stop loss @ 69.40
12/29/13 new stop loss @ 67.40
12/08/13 new stop loss @ 65.75
11/24/13 new stop loss @ 64.75

Current Target: DIS @ 97.50
Current Stop loss: 75.75
Play Entered on: 10/23/13
Originally listed on the Watch List: 10/13/13

Hess Corp. - HES - close: 87.61

Comments: 05/11/14:
A few days ago Oppenheimer raised their price target on HES to $110. That didn't stop HES from snapping a three-week win streak. The stock posted some profit taking and looks poised for a deeper pullback. I would not be surprised to see HES dip into the $84-86 area.

05/04/14 new stop @ 83.45
04/30/14 HES delivered better than expected earnings and revenues
04/22 trade opened. HES opens at $87.50
*option entry price is an estimate since the option did not trade at the time our play was opened.
04/21 HES closes at $87.78, above our entry trigger of $87.50

Current Target: HES @ 109.00
Current Stop loss: 83.45
Play Entered on: 04/22/14
Originally listed on the Watch List: 04/06/14

Honeywell Intl. - HON - close: 92.80

Comments: 05/11/14:
HON is still going nowhere fast. Shares eked out a small gain for the week. HON is stuck in a wide trading range between support near $90 and resistance near $96.00. You can also see that HON has a multi-week trend of lower highs pushing the stock closer toward its long-term bullish trend of higher lows.

More conservative investors may want to just take profits now.
I am not suggesting new positions at this time.

04/27/14 investors may want to just take profits now!
03/02/14 new stop loss @ 89.75, adjust target to $99.00
02/09/14 new stop loss @ 87.45
12/29/13 new stop loss @ 84.85
12/22/13 adjust the exit target to $98.00
...please see earlier newsletter for prior comments...
The plan was to use small positions to limit our risk.

Current Target: exit when HON hits $99.00
Current Stop loss: 89.75
Play Entered on: 05/07/13
Originally listed on the Watch List: 05/04/13

Joy Global Inc. - JOY - close: 58.96

Comments: 05/11/14:
Bingo! Last weekend I cautioned investors that JOY would dip toward $58 and its 50-dma. Sure enough JOY fell to the 50-dma and is trying to bounce. I would be tempted to use this pullback as a new bullish entry point but I am growing concerned about the broader market. Investors might want to wait and see if JOY can close above $60.00 again before initiating positions.

Current Target: We're aiming for the $75-80 zone
Current Stop loss: 55.75
Play Entered on: 04/08/13
Originally listed on the Watch List: 04/06/14

NuStar Energy - NS - close: 57.33

Comments: 05/11/14:
NS spent the week consolidating sideways between $56 and $58. I warned investors last weekend that NS looked like it was headed for the $54-56 zone so I do not believe the pullback is over.

I am not suggesting new positions at this time.

Earlier Comments:
Our target is $64.50.
More aggressive investors with a longer time frame may want to aim higher since the point & figure chart is targeting an $87 target.

04/04/14 our play opens. NS @ 55.25
*option entry price is an estimate since the option did not trade at the time our play was opened.
04/03/14 NS closes above $55.25
Current Target: exit calls when NS hits $64.50
Current Stop loss: 51.75
Play Entered on: 04/04/14
Originally listed on the Watch List: 03/23/14

QUALCOMM Inc. - QCOM - close: 79.50

Comments: 05/11/14:
It as a relatively quiet week for shares of QCOM. The stock did manage another gain but shares mostly churned sideways in the $78.50-80.00 zone. I am still cautious on QCOM following its earnings results in late April.

I am not suggesting new positions. If QCOM rolls over I'm looking for support near its 100-dma.

Current Target: $85.00
Current Stop loss: 74.70
Play Entered on: 11/15/13
Originally listed on the Watch List: 11/03/13

Wells Fargo & Co. - WFC - close: 49.08

Comments: 05/11/14:
The financial sector and shares of WFC are still drifting sideways. The Federal Reserve was making headlines again on Thursday when they announced a new rule that would limit the size of the nation's biggest banks. The proposed rule, which is now open for public comment, would prohibit any mergers if the new merged company would have liabilities that exceed 10% of the aggregate consolidated liabilities of all financial companies. The Fed is accepting comments on this rule through July 8th, 2014. Based on a 2011 study by the Federal Stability Oversight Council the only banks that might currently be affected by this new rule are Bank of America (BAC), Citigroup (C), J.P.Morgan Chase & Co (JPM), and Wells Fargo (WFC).

WFC's long-term trend is still higher but shares could easily see a correction lower into the $46-47 area.
I'm not suggesting new positions at this time.

CLOSED Plays

Comments: 05/11/14:
CLX was a big disappointment this past week. Normally the stock is not that volatile but these last two weeks have seen a big price swing for CLX.

Our trade was triggered two weeks ago with a breakout to new three-month highs and a close above $91.50. Shares then dropped on a disappointing earnings report and continued to sink breaking down through several layers of support. Our stop loss was hit at $86.90 on May 6th.

05/06/14 stopped out at $86.90
**option exit price is an estimate since the option did not trade at the time our play was closed.
05/01/14 CLX drops on disappointing earnings news and lowered guidance.
04/29/14 trade opened. CLX opens at $91.74
04/28/14 CLX closes above $91.50, our suggested trigger

Dropped Watch List Entries

New Watch List Candidates:

AIG is in the financial sector. They are one of the largest financial companies on the planet and provide insurance for commercial, institutional, and individual clients.
The company recently reported earnings in May and beat the bottom line estimate by 15 cents with a profit of $1.21 per share. Revenues were a miss at $8.23 billion versus the $8.62 billion estimate. AIG was at the center of the U.S. government bailout fiasco of 2008-2009 that was so unpopular outside of Wall Street. What many people don't know is that the U.S. actually made a $22.7 billion profit on bailing out AIG.

The stock has more than doubled from its late 2011 lows. The rally stalled back in October last year but it looks like AIG has been building a new base with a six-month trading range in the $47-53 range. A breakout could signal the beginning of its next leg higher.

Currently AIG has resistance in the $53.25 region. I am suggesting we wait for AIG to close above $53.75 and then buy calls the next morning with a stop loss at $49.75. Our long-term target is the $65-70 zone. Currently the point & figure chart is bullish with a $64 target.

Breakout trigger: Wait for AIG to close above $53.75
then buy calls the next day with a stop at $49.75

CHK is in the basic materials sector. The company produces natural gas, oil and natural gas liquids (NGL). The company is one of the largest independent energy companies in the U.S. with significant domestic production. The company just reported earnings this past week and CHK delivered a profit of 59 cents a share, beating Wall Street's 48 cent estimate. CHK's Q1 revenues rose +47% to $5.05 billion, which was well above analysts' estimates. CHK's management raised their 2014 cash flow guidance.

The earnings results were good news but wait there is more. CHK also said that the S.E.C. had ended its investigation into the company and its former CEO Aubrey McClendon. The SEC said they "did not intend to recommend any enforcement action" (source: Reuters). With all this good news shares of CHK soared to new 52-week highs and now look poised to breakout past round-number resistance at $30.00.

I am suggesting we wait for CHK to close above $30.25 and then buy calls the next day with a stop loss at $26.75. There is potential resistance near $36.00 but we're going to set our long-term target at $40.00.

Breakout trigger: Wait for a close above $30.25
then buy calls the next day with a stop at $26.75

Active Watch List Candidates:

Illinois Tool Works, Inc. - ITW - close: 86.23

Comments: 05/11/14:
Traders continue to buy the dips in ITW and shares are inching higher. The stock looks poised for a breakout past short-term resistance in the $86.00 area. I don't see any changes from my prior comments. Odds are good we could see ITW meet our entry point requirements soon.

Earlier Comments:
I am suggesting we wait for a close above $86.50. If that occurs we can buy calls the next morning with a stop loss at $81.75. Our long-term target is the $98-100 zone.

Breakout trigger: Wait for a close above $86.50
then buy calls the next morning with a stop at $81.75

BUY the 2015 Jan $90 call (ITW1517a90) current ask $2.90

- or -

BUY the 2016 Jan $90 call (ITW1615a90) current ask $6.30

Originally listed on the Watch List: 05/04/14

Michael Kors - KORS - close: 91.82

Comments: 05/11/14:
KORS found support near the $90 level this past week. Depending on your risk tolerance there are a variety of entry points one could use for KORS. You could wait for a breakout past the $95.00 level or you could wait for another dip toward support near $86.00. However, retail stocks have been having a really rough time this year. KORS is an exception but they could blame the weather for a lousy Q1. I am concerned that KORS could disappoint when they report earnings on May 23rd. Therefore, tonight we're going to remove KORS as a candidate and re-evaluate it after it reports earnings.

Trade did not open.

05/11/14 removed from the newsletter.
Look at KORS again after they report earnings on May 23rd.
05/04/14 move the buy-the-dip trigger from $81.00 to $83.00.
move the stop loss to $79.00

Originally listed on the Watch List: 04/13/14

Sturm, Ruger & Co. - RGR - close: 67.41

Comments: 05/11/14:
I was concerned that RGR might be volatile. Shares did see some volatility with $4.00 swings last week but not how I expected. RGR reported earnings on May 5th. The street was expecting a profit of $1.12 a share on revenues of $157.7 million. RGR beat both estimates with a profit of $1.22 a share and revenues of $169.9 million. It was impressive since they were facing tough comparisons to a year ago.

Traders did buy the post-earnings dip near $64 and RGR looks poised to challenge resistance in the $69-70 zone. I am adjusting our entry point strategy. Wait for RGR to close above $70.25. If RGR can close above $70.25 then we'll buy calls the next morning with a stop loss at $64.75.
Our long-term target is the $90-100 zone.

This is an aggressive trade, use small positions.

Wait for RGR to close above $70.25, then buy calls the next day.

BUY the 2015 Jan $85 call (RGR1517a85) current ask $1.90

05/11/14 adjust entry point strategy. Wait for RGR to close above $70.25 and use a stop loss at $64.75.

Originally listed on the Watch List: 05/04/14

Williams Sonoma - WSM - close: 63.43

Comments: 05/11/14:
WSM struggled on May 6th with a breakdown to new multi-week lows. Fortunately investors bought the dip and shares have recovered. The stock is now up three out of the last four weeks and WSM looks poised to breakout past resistance in the $63.50-64.00 area.

Earlier Comments:
I am suggesting we wait for WSM to close above $64.50. If that occurs we can buy calls the next day with a stop loss at $59.75. Our long-term target is the $75-85 zone.

Breakout trigger: Wait for WSM to close above $64.50
then buy calls the next morning with a stop at $59.75.